Living by the Stockdale Paradox

Navy pilot shot down in Vietnam... Entering the world of Epictetus... Living by the Stockdale Paradox... At least control the process... Hope for the best, prepare for the worst... A way to anticipate failure...

James Stockdale was flying 575 mph at tree-top level...

The combat mission that the U.S. Navy pilot was heading up on September 9, 1965, was similar to the 150 other missions he'd flown during his three years in North Vietnam...

But this time, Stockdale's Douglas A-4 Skyhawk was hit by anti-aircraft fire... Stockdale told an audience of Navy cadets three decades later...

I couldn't steer after it was on fire, [the] control system [was] shot out.

He ejected from the burning plane. He explained...

I had about 30 seconds to make my last statement in freedom before I landed on the main street of that little village right ahead... I whispered to myself: Five years down there at least. I'm leaving the world of technology and entering the world of Epictetus.

Epictetus was a Greek slave-turned-philosopher from the first century A.D. and one of the founding fathers of Stoicism... His writings were high on Stockdale's reading list.

Eventually becoming a Navy admiral, Stockdale would later say that the philosophy of Stoicism had been critical to his survival after being held at the infamous "Hanoi Hilton" in Vietnam... where captured American military personnel ‒ including the late Sen. John McCain ‒ were tortured and beaten when they were held captive.

Stoicism is a personal operating system lots of people use to tackle the many challenges of life ‒ most of which are less daunting than being a prisoner of war... like sitting in traffic, negotiating a raise, or dealing with a relationship...

And as I (Kim Iskyan) will explain in today's Digest, Stoicism is also a powerful philosophy to navigate the challenges of finance, investment, and portfolio management ‒ especially in today's volatile markets...

The principles that kept Stockdale alive while he withstood torture in a rat-infested Vietnamese jail can also help us reduce the role of emotions in our investment decisions... focus on process rather than outcome... anticipate and prepare for setbacks... lean into failure when it happens... and replace optimism with something more realistic.

Stoicism is often confused with being stoic...

Being stoic refers to the state of not showing emotion... keeping a poker face when your house burns down or when the stock you're holding drops 30%...

But Stoicism – that is, the philosophy, with a capital "S" – isn't about keeping emotions inside... One of the main focuses of Stoicism is to limit our negative reaction to bad things happening ‒ that is, not to allow ourselves to get caught up in pointless, damaging, and harmful self-blame when things don't go our way...

As Epictetus wrote...

It's not what happens to you, but how you react to it that matters.

Of course, if only it were so easy...

It's pointless to worry about things we can't control...

We can't control whether the sun rises... what others think of us... or whether the stock market goes up or down...

But it does make sense to concentrate on those issues that we can control... things like our opinions, our character, our actions, and the financial goals we set for ourselves.

I paraphrase William Irvine, as he explains it in A Guide to the Good Life: The Ancient Art of Stoic Joy... Things that we can only partially control comprise a lot of life: Whether you win a tennis match hinges on your skills (up to you) but also those of your opponent (out of your control)... Whether you get to the airport on time is partly a function of whether you leave on time (up to you) as well as the traffic en route (out of your control)...

Similarly, you can analyze a company's fundamentals, study the balance sheet, survey the competitive universe, look at the stock's technicals, and scour the 10-K to make a smart investment decision... And you can still be wrong ‒ because whether a share price rises or falls is ultimately beyond your control...

While we often can't control an outcome, we can still control the process...

We can't control share prices... but we can control the manner in which we make investment decisions... A consistent, disciplined process that removes emotion from the equation is far more effective over the long term at generating positive outcomes...

University of Alabama coach Nick Saban, the winningest coach in college-football history, is often credited with pioneering a philosophy called "The Process"... As author and Stoicism proponent Ryan Holiday explains, Saban trains his players to focus on...

[D]oing the absolutely smallest things well ‒ practicing with full effort, finishing a specific play, converting on a single possession. A season lasts months, a game lasts hours, catching up might be four touchdowns away, but a single play is only a few seconds. And games and seasons are constituted by seconds.

If teams follow The Process, they tend to win. They overcome obstacles and eventually make their way to the top without ever having focused on the obstacles directly.

In other words... follow a structured, deliberate, thoughtful method ‒ and set small, concrete goals that are within your control to achieve.

In investing, this could translate into automatically setting aside a certain amount of money each month... whether it's for retirement, a kid's college fund, or a dream house... and investing it into, say, an index fund.

It's also about developing an investment and portfolio-management framework ‒ including, for example, a structured buy-and-sell discipline... and strict stop-loss levels ‒ that works for you... and then finding the discipline to stick with it... even when markets don't move the way you want them to.

A strong process involves 'internalizing' your objectives...

Legendary New England Patriots football coach Bill Belichick is known for exhorting his players to "Do your job!" – echoing the spirit of Stoical philosopher Seneca...

Belichick is telling each player to perform his assigned task – whether it's to throw a block, make a catch, or tackle an opponent... and let the results of the game take care of themselves.

Belichick tells his players to focus on what they can control – and ignore what they can't.

This is a way of "internalizing" your goals – framing them in terms of what you can do... and ignoring the expectations of others or anything else you can't control...

Trying to control what you cannot control only leads to frustration ‒ like winning ("if only he'd made that throw, we'd have won the game")... or happiness ("if only she would marry me, I'd be happy")... or success ("if I get this promotion, I'll be satisfied at work")... or financial security ("if the market moves up 10%, my retirement is set").

Internalizing your goals doesn't mean losing sight of the bigger picture. You want to execute all the plays in a game successfully so that you win the game... You analyze the data before making an investment decision, hoping that the stock will rise in value...

And the fact remains... If your team loses or if your portfolio balance falls, no matter how successful you were at doing your own job and executing your process... you'll still be disappointed.

Stoicism also prescribes a way to anticipate failure...

No matter how well you do your job, lots of things can go wrong... Perhaps you make a mistake, or something beyond your control doesn't work out, or a person you were relying on doesn't perform his task.

After all, we can limit how much we rely on factors outside our control... but we can't eliminate them altogether.

Stoics have a way to limit the downside of error... and of the psychological tax of it. In Latin, it's premeditatio malorum – literally, the "premeditation of evils."

Self-help guru Dale Carnegie, author of the 1936 classic How to Win Friends and Influence People, echoed the Stoics in his anxiety-dampening approach of "awfulizing"...

What he means is this... Think about what could go wrong before something goes wrong... Conduct a "premortem."

As Seneca wrote...

Nothing happens to the wise man against his expectation.

That doesn't mean that you should expect the worst. No one likes a pessimist... And clouding your judgment with negativity can have a self-fulfilling dimension to it.

Instead, Stoicism suggests that you anticipate what could go wrong... and prepare accordingly. As my colleague Dan Ferris says, "Prepare, don't predict."

And that can mean stress-testing your portfolio for the worst that could happen... What if Russia fully invades Ukraine? Or, what if the Fed hikes interest rates by 50 basis points at its next meeting? Or, what if that hot tech company reports dismal earnings?

Writer Nassim Taleb refers to this as fragility... what he describes as having a lot to lose and little to gain by something... Taleb explained further in Antifragile: Things That Gain From Disorder...

Seneca's practical method to counter such fragility was to go through mental exercises to write off possession, so when losses occurred, he would not feel the sting ‒ a way to wrest one's freedom from circumstances.

Consider the worst thing that could happen – and prepare accordingly.

And if – or when – you fail, embrace it...

Stoic philosopher Marcus Aurelius said, "The impediment to action advances action. What stands in the way becomes the way."

He was talking about viewing setbacks as a challenge – and to lean into them instead of burying them...

Stoicism embraces amor fati, which is Latin for "love of fate"... Rather than bemoaning a setback, learn from it.

As Ryan Holiday explained amor fati...

Treat every moment ‒ no matter how challenging ‒ as something to be embraced, not avoided. To not only be OK with it but love it and be better for it. So that oxygen to a fire, obstacles and adversity become fuel for your potential... when we accept what happens to us... we are left with this: loving whatever happens to us and facing it with unfailing cheerfulness and strength.

After all, Bill Belichick's teams have been defeated in 156 football games... and he has lost more Super Bowls than all but three coaches have ever won.

Warren Buffett has endured entire decades of underperformance...

In the end, it's only by digging into failure ‒ understanding why we lost a game or had a bad financial outcome ‒ that we can grow.

Admiral Stockdale's warning for optimists...

Through premeditatio malorum and amor fati, we're reducing the chance of failure by anticipating what might cause it... and learning from failure when failure eventually happens.

What Stoicism doesn't advocate is looking on the sunny side of life ‒ and pretending that an upbeat attitude will change anything...

While he was being tortured in prison, Stockdale didn't know that he was eventually going to go home... Coping with the uncertainty of what the future held was one of the many challenges of captivity.

Stockdale later explained that his fellow prisoners who were optimists ‒ who continuously anticipated that their release was just around the corner ‒ were eventually worn down and broken as their captivity dragged on...

A wiser approach is what business writer Jim Collins coined the Stockdale Paradox in his book Good to Great...

You must never confuse faith that you will prevail in the end ‒ which you can never afford to lose ‒ with the discipline to confront the most brutal facts of your current reality, whatever they might be.

In other words, have faith and stay upbeat... but confront reality.

Or, as Epictetus said...

What, then, is to be done? To make the best of what is in our power, and take the rest as it naturally happens.

And there's little place for empty optimism in investing... Hoping for a 10-bagger to rescue your retirement ‒ and taking reckless risks that violate your process ‒ is a recipe for disaster...

Remember... markets, stocks, and asset prices don't care how you feel. To that end, Stoicism is a reminder to take the emotion out of what you're doing... to focus on what is within your control... to emphasize process... and let results take care of themselves.

Anticipate failure – and embrace it when it (eventually and inevitably) happens.

After 30 seconds, Stockdale's plane plummeted to Earth...

He sustained grievous injuries in the crash, then was severely beaten by villagers... As the highest-ranking American prisoner of war in North Vietnam, he subsequently endured unimaginable cruelty during nearly eight years of captivity.

But all the while, he maintained a strong spirit and held firm to some of the tenets of Stoicism that we haven't addressed here... including courage, virtue, and strength of resolve.

Whether it's as major an event as getting shot from the sky and held in captivity for years... or as small as having a stock suddenly go the wrong way... employing the tools of Stoicism can help you deal with what life brings your way.

And while you can't necessarily prevent bad things from happening, you can prevent making them worse by facing them with strength...

New 52-week highs (as of 2/18/22): Alcoa (AA), Altius Renewable Royalties (ARR.TO), Enstar (ESGR), Coca-Cola (KO), and United States Commodity Index Fund (USCI).

In today's mailbag, feedback on Dan Ferris' Friday Digest... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"Dan, As well as being entertaining, your commentary on markets in general, and current market conditions specifically, are spot-on. The 'bezzle' reference is brilliant.

"I almost exclusively invest in value stocks that have proven track records and consistent dividends. Thank you for providing perspective on today's insane markets." – Paid-up subscriber Paul B.

"That was a fun article. Wow, the Economist calling a crash also. I am worried enough to not need everyone getting bearish at once. The more negative stuff I hear the more I say this does not sound correct.

"I have to say I agree with most of what you say as far as valuations go. I am boring and conservative and don't like hype or pressure when trying to invest. Utter torture the meme stuff has been..." – Paid-up subscriber John S.

"Dan, Thank you for stepping up and sharing your wisdom and passions. I'm so happy that you care about your subscribers and investors. Your research and writing have hit a new plateau and I try to read every article you publish." – Paid-up subscriber John B.

"Great essay. Reminds me of my father watching the stock market ticker on CNBC with the volume turned off. He always said buy good companies and forget you own them. Thanks for the reminder." – Stansberry Alliance member Ralph B.

Good investing,

Kim Iskyan
Olney, Maryland
February 22, 2022